Former Banker Says Experience Best Teacher About Bad Loans

April 04, 1985|by BOB SHARPE, The Morning Call

The best way bankers can learn about bad loans is the same way to learn about fire - get burned a few times.

And as bad loans can be an expensive lesson, it's cheaper to benefit from the experiences of others than to repeat costly mistakes, former bank president Lawrence A. Darby told more than 130 area loan officers yesterday at a meeting of the Robert Morris Associates.

Darby's seminar at the Holiday Inn West in South Whitehall Township featured a training videotape developed by his St. Louis company, Banker's Training & Consulting Co., of which Darby is president.

He later spoke to about 160 commercial loan and credit officers from banks in Bucks, Berks, Lehigh, Montgomery and Northampton counties on the topic of bank training at the group's annual dinner meeting.

While the seminar was aimed at bankers, any company taking out a business loan may be interested in what banks consider in determining a loan's risk.

Darby, who was a loan officer for six years before being president of the $150-million Mark Twain South County Bank in Missouri, said loan defaults in 1982 absorbed about $8 billion of U.S. banks' $27 billion in income.

The videotape, titled "The Worst Loan I Ever Made," resulted from interviews with 23 bankers across the country. One of the bankers told of a $175-million loss his bank took on what seemed initially a solid loan.

The borrower, a 40-year-old family business, had a good balance sheet, on- time receivables and satisfied suppliers and customers, the banker recalled. Collateral consisted of liens on the company's equipment and inventory.

The company went bankrupt. What went wrong?

The banker, having learned his lesson, admitted to not paying enough attention to several developments.

When the company's inventory grew faster than its sales, the banker took the company's word that a bountiful supply was healthy for filling quick orders and that keeping employees working during slack sales periods avoided layoffs and kept experienced workers.

The banker learned too late that the company's owner was diverting cash from the company into a side venture that quickly failed. The company's financial statements routinely were late in arriving at the bank.

He also learned too late that a key production manager quit, and by not keeping in touch with the company's customers, the banker learned too late the company had quality control problems that arose after the production manager left.

The defective inventory that was piling up was worthless to the bank as collateral.

Another banker interviewed for the videotape said it was never too soon to rein in a loan that was going bad.

Some early warning signals that should raise red flags, said Darby, include:

- Late financial statements provided to the bank.

- Change in attitude or lifestyle of the borrower.

- Change in the company's terms of sale or credit to its customers.

- Increase in return of unsold or faulty product.

- Management turnover. Employees are the first to know when trouble arrives.

- Change in banks for no apparent reason.

- Rapid build-up or decline in inventories.

- Change in the company's loan agreement or a sudden need for cash.

- Sales of products from floor plan inventory.

- Entering into a sale/leaseback agreement, usually a sign the company needs cash.